Subscribe

Tuesday, April 1, 2014

Incentives & Financial Shenanigans

After talking a little bit about incentives, nothing better than debating some of the possible outcomes. As we've learned in the previous entry, high paychecks with misaligned terms may be an issue: CEOs feeling pressured about beating analysts' short-term quarterly estimates may 'play dumb' destroying shareholder value in detriment of his own paycheck. As one CEO has put it,

"The most important thing we do is meet our numbers. It's more important than any individual product. It's more important than any individual philosophy. It's more important than any individual cultural change we're making. We must stop everything else when we don't make the numbers." - Joseph Nacchio, speech at January 2001 employee meeting, disclosed in a U.S. SEC complaint (March 2005)

Aggressive accounting may take its form in different ways, such as booking revenues too soon, recognizing undue revenue (nevermind PoC accounting method!), misclassifying items so they don't pass through the P&L, shifting current expenses to the next period, boosting operating income by one-offs and so on.

Since executives are well regarded, competent and competitive people, they do not like to lose - I get that. But how could both (i) investors analyze companies financial results in a proper timeframe and (ii) executives be aligned with the right incentives and KPIs so performance evaluation for both parties would be fair and accretive for the three entities in question, namely investors, executives and the company itself?

As Munger put it in one of his speeches,

“The system is responsible in proportion to the degree that the people who make the decisions bear the consequences.”

I do not aspire to share a proposal, but things such as

A shareholder base aligned with the strategic planning horizon of a company;

A well calibrated compensation package, with the vesting period aligned with the strategic planning timeframe (even in Brazil there are companies with 10-year vesting periods);

A more spaced financial results release (half yearly, maybe?);

should be steps in the more correct direction. That's my 2 cents. What do you think?